Banks Should Recognize Credit Losses Earlier, IASB Says

Banks should be required to recognize losses on credit portfolios before the assets go into default, an international accounting standards body said today.

The measures, known as the expected loss model, would mark a shift from the incurred loss model, which allows banks to wait until “financial assets are close to default,” the International Accounting Standards Board said in a report. Banks would have to recognize losses on portfolios as they deteriorate in quality, under the proposals.

“We believe the model leads to a more timely recognition of credit losses,” Hans Hoogervorst, chairman of the London-based IASB, said in the statement. “At the same time, it avoids excessive front-loading of losses, which we think would not properly reflect economic reality.”

The Group of 20 nations set up a group to examine alternatives to the incurred loss model following the 2008 financial crisis. The rules had been criticized for “delaying the recognition of losses” and for failing to accurately reflect losses on credit portfolios “that were expected to occur,” said the IASB, which is a global body in charge of harmonizing accounting standards.

The proposals “provide enhanced transparency to an entity’s credit risk and are likely to increase the credit loss provision recorded by many financial institutions,” Tony Clifford, an accountant at Ernst & Young LLP, said in an e-mailed statement.

No ‘Panacea’

The proposals were developed in cooperation with the Financial Accounting Standards Board, the rule maker for U.S. banks, and “simplified to reflect feedback received from interested parties,” the IASB said.

“It is important to be realistic; this is not going to be the panacea,” Nigel Sleigh-Johnson, head of the financial reporting group at the Institute of Chartered Accountants in England and Wales, said in an e-mailed statement. “There are potential pitfalls linked to any model.”

The IASB and the U.S.’s FASB have previously diverged on standards, including accounting for exposure to derivatives.